Thursday, December 18, 2008
The SEC voted to require public companies and mutual funds to use interactive data for financial information. With interactive data, all of the facts in a financial statement are labeled with unique computer-readable "tags," which function like bar codes to make financial information more searchable on the Internet and more readable by spreadsheets and other software. Investors will be able to find specific facts disclosed by companies and mutual funds, and compare that information with details about other companies and mutual funds to help them make investment decisions.
For public companies, interactive data financial reporting will occur on a phased-in schedule beginning next year. The largest companies who file using U.S. GAAP with a public float above $5 billion will be required to provide interactive data reports starting with their first quarterly report for fiscal periods ending on or after June 15, 2009. This will cover approximately 500 companies. The remaining companies who file using U.S. GAAP will be required to file with interactive data on a phased-in schedule over the next two years. Companies reporting in IFRS issued by the International Accounting Standards Board will be required to provide their interactive data reports starting with fiscal years ending on or after June 15, 2011.
Companies will be able to adopt interactive data earlier than their required start date. All U.S. public companies will have filed interactive data financial information by December 2011 for use by investors.
Mutual funds will be required to begin including data tags in their public filings that supply investors with such information as objectives and strategies, risks, performance, and costs. A mutual fund also would be required to post the interactive data on its Web site, if it maintains one.
The SEC earlier this year unveiled its new financial reporting system — IDEA (Interactive Data Electronic Applications) — to accept interactive data filings and give investors faster and easier access to key financial information about public companies and mutual funds. The new IDEA system is supplementing and eventually replacing the agency's 1980s-era EDGAR database, marking the SEC's transition from collecting forms and documents to making financial information itself freely available to investors.
The SEC filed insider trading charges in another "pillow-talk" case, alleging that a former registered representative at Lehman Brothers misappropriated confidential information from his wife, a partner in an international public relations firms, and tipped a number of clients and friends. The SEC's complaint alleges that from at least March 2004 through July 2008, Matthew Devlin, then a registered representative at Lehman Brothers, Inc. ("Lehman") in New York City, traded on and tipped at least four of his clients and friends with inside information about 13 impending corporate transactions. According to the complaint, some of Devlin's clients and friends, three of whom worked in the securities or legal professions, tipped others who also traded in the securities. The complaint alleges that the illicit trading yielded over $4.8 million in profits. Because the inside information was valuable, some of the traders referred to Devlin and his wife as the "golden goose." The complaint further alleges that by providing inside information, Devlin curried favor with his friends and business associates and, in return, was rewarded with cash and luxury items, including a Cartier watch, a Barneys New York gift card, a widescreen TV, a Ralph Lauren leather jacket and Porsche driving lessons.
The complaint alleges that, based on the information provided by Devlin, the defendants variously purchased the common stock and/or options of the following public companies: InVision Technologies, Inc.; Eon Labs, Inc.; Mylan, Inc.; Abgenix, Inc.; Aztar Corporation; Veritas, DGC, Inc.; Mercantile Bankshares Corporation; Alcan, Inc.; Ventana Medical Systems, Inc.; Pharmion Corporation; Take-Two Interactive Software, Inc.; Anheuser-Busch, Inc.; and Rohm and Haas Company. At the time that Devlin tipped the other defendants about these companies, each company was confidentially engaged in a significant transaction that involved a merger, tender offer, or stock repurchase.
The SEC's complaint names nine defendants as well as three relief defendants. The U.S. Attorney's Office for the Southern District of New York filed related criminal charges today against some of the defendants named in the SEC's complaint.
Wednesday, December 17, 2008
The Wall St. Journal reports that President-Elect Obama will appoint Mary Schapiro as Chair of the SEC. Ms. Schapiro is currently CEO of FINRA; she has previously served on both the SEC and CFTC -- useful if consideration will be given to merging the two agencies. She is widely respected among all constituencies. WSJ, Obama Names Schapiro SEC Chief.
Today the SEC approved a rule, 151A, that will bring most, if not all, indexed annuities within the definition of "security" and subject them to the registration and antifraud provisions of the securities laws. The distributors of indexed annuities took the position that indexed annuities were excluded from the definition of "security" by reason of the "insurance products" exclusion in section 3(a)(8), and the SEC apparently acquiesced to this interpretation until this rule-making process. Rule 151A was proposed in June, which makes this a speedy adoption process by SEC standards, and thousands of letters, principally from the insurance industry and its agents, were filed in opposition. In his opening remarks, Christopher Cox emphasized that indexed annuities are complicated products that are difficult to understand; their sales are frequently aimed at senior investors, and that regulators have been concerned about abusive tactics used in using these products. (It has been reported that Cox's interest in this area stems, at least in part, from his mother's purchase of an indexed annuity that was unsuitable for her needs.)
The SEC's new rule provides that an indexed annuity is not an "annuity contract" under the insurance exemption if the amounts payable by the insurer under the contract are "more likely than not" to exceed the amounts guaranteed under the contract. (I confess that I found the methodology set forth in the proposing release on how to determine the "more likely than not" question virtually incomprehensible; others more knowledgeable than I told me that it would encompass virtually all indexed annuities. We must await the publication of the final rule and accompanying release to see if the concept is expressed more clearly.)
Troy Paredes, the newest SEC Commissioner and former law professor at Washington University at St. Louis, filed a dissent, stating that the rule exceeds the scope of the SEC's statutory authority by eliminating indexed annuities from the "insurance product" exemption.
We can expect a judicial challenge from the insurance industry.
Christopher Cox's mea culpa on the SEC's failure to heed "credible and specific allegations," going back to 1999, about Madoff's fraud:
Since Commissioners were first informed of the Madoff investigation last week, the Commission has met multiple times on an emergency basis to seek answers to the question of how Mr. Madoff's vast scheme remained undetected by regulators and law enforcement for so long. Our initial findings have been deeply troubling. The Commission has learned that credible and specific allegations regarding Mr. Madoff’s financial wrongdoing, going back to at least 1999, were repeatedly brought to the attention of SEC staff, but were never recommended to the Commission for action. I am gravely concerned by the apparent multiple failures over at least a decade to thoroughly investigate these allegations or at any point to seek formal authority to pursue them. Moreover, a consequence of the failure to seek a formal order of investigation from the Commission is that subpoena power was not used to obtain information, but rather the staff relied upon information voluntarily produced by Mr. Madoff and his firm.
In response, after consultation with the Commission, I have directed a full and immediate review of the past allegations regarding Mr. Madoff and his firm and the reasons they were not found credible, to be led by the SEC's Inspector General. The review will also cover the internal policies at the SEC governing when allegations such as those in this case should be raised to the Commission level, whether those policies were followed, and whether improvements to those policies are necessary. The investigation should also include all staff contact and relationships with the Madoff family and firm, and their impact, if any, on decisions by staff regarding the firm.
The Commission believes strongly that it is vital that SEC investigators, examiners, and enforcement staff be above reproach while conducting their duties, in order to ensure the integrity and effectiveness of the SEC. In addition to the foregoing investigation, I have therefore directed the mandatory recusal from the ongoing investigation of matters related to SEC v. Madoff of any SEC staff who have had more than insubstantial personal contacts with Mr. Madoff or his family, under guidance to be issued by the Office of the Ethics Counsel. These recusals will be in addition to those currently required by SEC rules and federal law.
Charlie Gasparino, in the Daily Beast, reports that Eric Swanson, an assistant director in the SEC inspections division and part of the team that examined the Madoff firm in 1999 and 2004, married Shana Madoff in 2007. Ms. Madoff is the niece of Bernard and the Madoff firm's compliance counsel.
Tuesday, December 16, 2008
FINRA announced details of a special arbitration procedure for investors seeking recovery of consequential damages related to their investments in Auction Rate Securities (ARS). Customers entitled to file for consequential damages under ARS-related settlements that firms have concluded with FINRA or the SEC may use this special procedure. Consequential damages equate to the harm investors suffered from their ARS transactions - such as opportunity costs or losses that resulted from investors' inability to access their funds because their ARS assets were frozen. Use of this special arbitration procedure is at the investor's sole option. Investors also have the option of bringing a case under standard arbitration rules or in any other forum where they may have the right to seek redress.
Under the special procedure, firms will pay all fees related to the arbitration, including filing fees, hearing session fees and all the fees and expenses of arbitrators. Firms cannot contest liability related to the illiquidity of the ARS holdings, or to the ARS sales, including any claims of misrepresentations or omissions by the firm's sales agents. Further, the firm cannot use in its defense an investor's decision not to sell ARS holdings before the relevant ARS settlement date or the investor's decision not to borrow money from the firm if it made a loan option available to ARS holders.
With the special arbitration procedure, investors now have the option of selling their ARS holdings back to the firms under the regulatory settlements and, at the same time, pursuing consequential damages. Investors who wish to seek punitive damages or attorneys' fees have the option to do so under FINRA's standard arbitration procedures.
To speed the arbitration process under the special procedure, cases claiming consequential damages under $1 million will be decided by a single, chair-qualified public arbitrator. In cases with consequential damage claims of $1 million or more, the parties can, by mutual agreement, expand the panel to include three public arbitrators.
For investors who opt for the standard FINRA arbitration process, disputes will be heard by a typical three-arbitrator panel consisting of two public arbitrators and one non-public arbitrator. However, under rules created by FINRA four months ago, that non-public arbitrator cannot have been associated with ARS since Jan. 1, 2005. That is, that non-public arbitrator cannot have worked for a firm that sold ARS, cannot have sold ARS him- or herself and cannot have supervised an individual who sold ARS since Jan. 1, 2005.
Also in the standard forum, ARS damage claims up to $50,000 will be heard by a single public arbitrator. In cases where damages claimed are over $50,000, the panel will consist of two public arbitrators and one non-public arbitrator who has had no association with ARS since Jan. 1, 2005.
As of the end of November, 275 ARS arbitrations claims have been filed in FINRA's Dispute Resolution forum under its standard arbitration procedure. Investors with pending claims against settled firms can switch to the special arbitration procedure as long as they are willing to limit their claims to consequential damages.
The SEC has announced final ARS settlements with Citigroup Global Markets, UBS Financial Services and UBS Securities, while FINRA has reached final settlements with WaMu Investments and First Southwest Company. The SEC has reached agreements in principle with Bank of America, Merrill Lynch, RBC Capital Markets and Wachovia. FINRA has reached agreements in principle with Mellon Capital Markets, City National Securities, Comerica Securities, Harris Investor Services, SunTrust Investment Services, SunTrust Robinson Humphrey and NatCity Investment, Inc. Formal settlements in those cases are expected to be announced soon. Additionally, FINRA is actively investigating an additional two dozen firms for ARS-related misconduct.
The SEC charged seven individuals and two corporations, including National Lampoon, Inc., with engaging in three separate fraudulent schemes to manipulate the market for publicly traded securities through the payment of prearranged kickbacks. Other defendants include National Lampoon's CEO, Daniel S. Laikin, as well as stock promoters, a consultant, and an officer of another company. The Commission's actions, filed in federal district court in Philadelphia, allege that, in each case, individuals who controlled the stock of a public company arranged with corrupt promoters and others to generate purchases of the company's stock in exchange for cash kickbacks. In each case, a witness secretly cooperating with the government (the "CW") was paid a kickback to make purchases in the stock. The goal of the manipulators was to create the appearance of market interest, induce public purchases of the stock, and ultimately increase the stock's trading price. For example, the Commission alleges that Daniel Laikin and another defendant paid at least $68,000 in cash kickbacks for the purchase of National Lampoon stock in order to artificially inflate the stock price.
National Lampoon, Inc., headquartered in Los Angeles, California, is a media and entertainment company that develops, produces and distributes media projects including feature films, television programming, online and interactive entertainment, home video, and book publishing. The company produced such widely known films as National Lampoon's Animal House, and the National Lampoon Vacation series. National Lampoon's common stock is registered with the Commission and is listed on the NYSE Alternext, formerly the American Stock Exchange ("AMEX"). Daniel S. Laikin, of Los Angeles, California, has been the Chief Executive Officer of National Lampoon since 2005. Laikin controls approximately 40 percent of the voting stock of National Lampoon.
The SEC settled insider trading chargese against Carl Loizzi, Rick A. Marano and William Marano. The SEC charged that, on two separate occasions, Rick Marano, a former senior analyst in the Life Insurance Group at Standard & Poor's Financial Rating Services (S&P), misappropriated material, non-public information obtained through his employment regarding proposed business transactions and tipped that information to his brother, William Marano, and Loizzi, a friend and former business partner of William Marano's. In total, the unlawful trading produced profits of over $1,100,000.
Without admitting or denying the allegations of the complaint, Rick Marano, William Marano and Loizzi each consented to the entry of a final judgment that permanently enjoins them from violating Section 10(b) of the Securities Exchange Act of 1934 (Exchange Act) and Exchange Act Rule 10b-5. The final judgments against Rick Marano and Loizzi require them to pay disgorgement of $45,000 and $305,000, respectively. The final judgments waive the remaining disgorgement and do not impose civil penalties based upon the defendants' sworn representations regarding their financial condition.
The complaint alleged that, in late April 2000, through his employment at S&P, Rick Marano misappropriated material, non-public information regarding a potential acquisition of ReliaStar Financial Corporation (ReliaStar) by ING Groep and, on or about April 27, 2000, tipped that information to William Marano and/or Loizzi. The complaint further alleged that defendants then purchased ReliaStar call option contracts (Loizzi also purchased ReliaStar common stock). The complaint charged that after the proposed acquisition was announced, Loizzi, William Marano and Rick Marano reaped trading profits of approximately $596,000, $200,000 and $83,000, respectively, on their sales of ReliaStar securities. The complaint further alleged that approximately one year later, Rick Marano again misappropriated material, non-public information regarding a potential acquisition of American General Corporation (AGC) by American International Group and tipped William Marano and/or Loizzi, who then purchased AGC call option contracts on April 3, 2001. Finally, the complaint charged that after the proposed acquisition was announced, Loizzi and William Marano reaped trading profits of approximately $253,000 and $20,000, respectively, on the sale of their AGC options.
In parallel criminal proceedings brought by the United States Attorney's Office for the Southern District of New York, Rick Marano, William Marano and Loizzi entered guilty pleas. Rick Marano was sentenced to a prison term of 15 months and fined $5,000, William Marano was sentenced to 24 months probation and fined $1,000 and Loizzi was sentenced to 36 months probation and fined $3,000.
Court Orders Disgorgement from One Wall St and Other Defendants for Sales of Unregistered Securities
On December 11, 2008 the United States District Court for the Eastern District of New York entered final judgments against defendants One Wall Street, Inc. ("One Wall Street"), Donte C. Jarvis, Willis "Bill" White III, and Cecil Baptiste, also known as John Latorri ("Baptiste") (collectively, the "defendants") and enjoined them from future violations of the registration provisions of Sections 5(a) and 5(c) of the Securities Act of 1933 and of the antifraud provisions of Section 17(a) of the Securities Act and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder. The Court ordered each of them to pay disgorgement, prejudgment interest and a civil monetary penalty. In addition the Court entered a final judgment against relief defendant La Shondra Hatter, Jarvis' wife, ordering her to pay disgorgement. Previously, on October 24, 2007, the Court had entered default judgments against each of these parties and reserved ruling on the Commission's motions for disgorgement, prejudgment interest and civil monetary penalties pending the recommendations of Magistrate Judge Arlene Rosario Lindsay for a determination of the amounts of each claim. In entering the final judgments, the Court adopted Judge Lindsay's recommendations, dated September 4, 2008.
The judgments order the disgorgement of the ill-gotten gains obtained by the defendants from at least 64 investors, many of whom were senior citizens, and at least one of whom lost a significant part of his life savings as a result of defendants' fraud. Considering the defendant's significant fraudulent conduct, the Court also imposed third-tier civil penalties on each of them and barred each of them from further violations of the registration and anti-fraud provisions of the federal securities laws.
The Commission's complaint alleged that One Wall Street, Jarvis, White, and Baptiste sold unregistered shares of One Wall Street to investors through numerous oral and written false and misleading statements. These defendants, together with Alan Brown, against whom a final judgment was entered in January 2008, raised at least $1.925 million from the investing public.
Judge Garaufis ordered that: (i) One Wall Street and Jarvis disgorge $1,925,620, together with prejudgment interest of $526,379.03, and pay a civil penalty of $1,925,620; (ii) White disgorge $1,000, together with prejudgment interest of $275.94, and pay a civil penalty of $30,000; and (iii) Baptiste disgorge $198,619.08, together with prejudgment interest of $47,895.44, and pay a civil penalty of $198,619.08. Judge Garaufis further ordered the relief defendant Hatter to disgorge the $166,570.80 she received from Jarvis, together with prejudgment interest of $32,122.07.
Monday, December 15, 2008
The SEC settled charges that Siemens Aktiengesellschaft ("Siemens"), a Munich, Germany-based manufacturer of industrial and consumer products, violated the anti-bribery, books and records, and internal controls provisions of the Foreign Corrupt Practices Act ("FCPA"). Siemens has offered to pay a total of $1.6 billion in disgorgement and fines, which is the largest amount a company has ever paid to resolve corruption-related charges. Siemens has agreed to pay $350 million in disgorgement to the SEC. In related actions, Siemens will pay a $450 million criminal fine to the U.S. Department of Justice and a fine of €395 million (approximately $569 million) to the Office of the Prosecutor General in Munich, Germany. Siemens previously paid a fine of €201 million (approximately $285 million) to the Munich Prosecutor in October 2007.
The SEC alleged that between March 12, 2001 and September 30, 2007, Siemens violated the FCPA by engaging in a widespread and systematic practice of paying bribes to foreign government officials to obtain business. Siemens created elaborate payment schemes to conceal the nature of its corrupt payments, and the company's inadequate internal controls allowed the conduct to flourish. The misconduct involved employees at all levels, including former senior management, and revealed a corporate culture long at odds with the FCPA.
During this period, Siemens made thousands of payments to third parties in ways that obscured the purpose for, and the ultimate recipients of, the money. At least 4,283 of those payments, totaling approximately $1.4 billion, were used to bribe government officials in return for business to Siemens around the world.
Without admitting or denying the Commission's allegations, Siemens has consented to the entry of a court order permanently enjoining it from future violations and ordering it to comply with certain undertakings regarding its FCPA compliance program, including an independent monitor for a period of four years. On December 15, 2008, the court entered the final judgment. Since being approached by SEC staff, Siemens has cooperated fully with the ongoing investigation, and the SEC considered the remedial acts promptly undertaken by Siemens. Siemens' massive internal investigation and lower level employee amnesty program was essential in gathering facts regarding the full extent of Siemens' FCPA violations.
Sunday, December 14, 2008
Reforming the Taxation and Regulation of Mutual Funds: A Comparative Legal and Economic Analysis, by John C. Coates IV, Harvard Law School, was recently posted on SSRN. Here is the abstract:
Most Americans invest through mutual funds. A comparison of US tax and securities law governing mutual funds with laws governing other collective investments, in both the US and in the EU, shows: (a) mutual funds are taxed less favorably and regulated more extensively in the US than direct investments or other collective investments, including alternatives available only to wealthy investors; (b) the structure of US regulation - numerous proscriptive bright-line rules written nearly 70 years ago, subject to SEC exemptions - makes success of US mutual funds dependent on the resources, responsiveness and flexibility of the SEC; (c) the US fund industry continues to be the world leader, but now lags domestic and foreign competitors, primarily because of US tax and securities law; and (d) while formal laws imposed on mutual funds in other countries are as or more restrictive and inflexible in most respects than US law, the resources and responsiveness of foreign fund regulators exceed the SEC in its oversight of mutual funds. The paper discusses a number of reforms to improve the treatment of middle class investments, including improvements in mutual fund taxation, ways to enhance the flexibility and resources of US fund regulators, modifications of the existing ban on asymmetric advisor compensation and the exclusion of foreign funds, and unjustified disparities in the treatment of mutual funds and mutual fund substitutes.
Supreme Court Amicus Brief of Law Professors in Support of Certiorari, Jones v. Harris Associates, No. 08-586, was recently posted on SSRN by William A. Birdthistle, Chicago-Kent College of Law. Amici curiae law professors filed this brief to urge the Court to grant the petition for certiorari and to clarify the proper scope of the fiduciary duty under Section 36(b) of the Investment Company Act that investment advisers owe to mutual fund shareholders with respect to the compensation that advisers receive. The brief addresses the Seventh Circuit's decision to disavow the long-established Gartenberg precedent and to hold, instead, that so long as an adviser make[s] full disclosure and play[s] no tricks, a plaintiff cannot prevail in a Section 36(b) action. Amici argue that the Seventh Circuit's decision creates a circuit split, elides a critical provision from the statutory text, and engages in a superficial market analysis.
U.S. Securities Regulation and Global Competition, by Donald C. Langevoort, Georgetown University Law Center, was recently posted on SSRN. Here is the abstract:
This essay introduces and comments on three articles in the Virginia Law & Business Review that address important questions of international competitiveness and U.S. securities regulation: the evolution of the Rule 144A market as a way for foreign issuers to tap U.S. capital without submitting to a mandatory disclosure regime; the emergence of international accounting standards to which the SEC seems eventually ready to submit; and "best execution" differences between trading platforms in the U.S. and the E.U.
Since courts and commentators frequently like to bemoan the naivete and greed of retail investors, I get a deep sense of satisfaction when the "smart money" turns out to be equally stupid. We have seen many examples of this in the past few months with the fall of the mighty banks that, as it turned out, failed to grasp the riskiness of the exotic investments in their portfolios. A few weeks ago, the New York Times ran an excellent article detailing Citigroup's failure to heed red flags as it engaged in ever-riskier bets, NYTimes, Citigroup Saw No Red Flags Even as It Made Bolder Bets (Nov. 23, 2008). Now this week two massive frauds perpetrated on wealthy investors have been exposed, both catching the regulators apparently by surprise.
Bernard Madoff is frequently described in the press as a "Wall St. fixture." Madoff founded the firm bearing his name in 1960 and has been a prominent member of the securities industry throughout his career. Madoff served as vice chairman of the NASD, a member of its board of governors, and chairman of its New York region. He was also a member of NASDAQ Stock Market's board of governors and its executive committee and served as chairman of its trading committee. This week he allegedly informed two senior employees that his investment advisory business was a fraud. Madoff told these employees that he was "finished," that he had "absolutely nothing," that "it's all just one big lie," and that it was "basically, a giant Ponzi scheme." The senior employees understood him to be saying that he had for years been paying returns to certain investors out of the principal received from other, different investors. Madoff admitted in this conversation that the firm was insolvent and had been for years, and that he estimated the losses from this fraud were at least $50 billion. According to regulatory filings, the Madoff firm had more than $17 billion in assets under management as of the beginning of 2008. It appears that virtually all assets of the advisory business are missing.
The press reports that many investors were suspicious of Madoff's activities -- the fact that he consistently achieved 10% returns, the secrecy surrounding his investment policies, the fact that his statements were audited by a small, obscure accounting firm -- and the SEC had previously investigated him and apparently found nothing to warrant bringing charges. NYTimes, Look at Wall St. Wizard Finds Magic Had Skeptics (Dec. 13, 2008).
The alleged scam perpetrated by high-profile attorney Marc S. Dreier sounds equally crude and audacious. According to today's New York Times, Dreier talked his way into a conference room at Solow Realty and proceeded to use the setting to sell phony promissory notes "issued" by Solow Realty. He was arrested in Toronto when he apparently tried the same scam but could not get past the receptionist at the offices of the Ontario Teachers' Pension Plan. He may have bilked investors out of as much as $380 million with his various scams. And what did Dreier do with the money? Apparently it not only supported his lavish life style, but that of the 200-some lawyers at his law firm. According to Dreier's lawyer, he attracted the "best and the brightest" legal talent by paying them top dollar. Well, maybe not so bright -- not only are those lawyers now looking for jobs but the Times also reports that Dreier allowed malpractice coverage to lapse. NYTimes, Lawyer Seen as Bold Enough to Cheat the Best Investors (Dec. 14, 2008).
Let's stay tuned for further developments.